Various investment fund structures providing for levered and unlevered accounts are known. In order to manage assets in a single portfolio while increasing the pool of investment assets, master-feeder investment structures are known. In general, master feeder investment structures include multiple feeder funds which invest in a master fund. The master fund, in turn, undertakes trading activity and provides a return to the feeder funds.
In order to increase potential gains on investments, private investment funds may invest on margin. In particular, Federal Reserve Regulations allow such funds to invest their own capital, as well as a certain percentage of borrowed capital typically provided by a prime broker. The prime broker determines the maximum amount of leverage to be provided. This leverage flows through in the return available to an investor in the fund. For example, an unlevered investor investing $100 in a fund with a 10% return would realize a gain of $10. However, an investor investing $100 in fund realizing the same 10% return, but also utilizing an additional $100 of borrowed funds, will realize a gain of $20, less the cost of funds borrowed (i.e., interest charges, fees, legal costs and similar amounts) for a net return that could be significantly greater than 10%. Similarly, losses in a leveraged fund will be greater than those in an unleveraged fund and will be further increased by the cost of funds borrowed.
In order to provide enhanced leverage, investment structures with multiple levels of leverage are known. Such investment structures utilize leverage at two levels: (a) the investor level (i.e., the level at which investors purchase interests in a fund) and (b) the portfolio level (i.e., margin lending). FIGS. 1 and 2 illustrate such investment structures, configured in either a master-feeder structure or as segregated accounts, respectively. Referring first to FIG. 1, a known master-feeder investment structure is illustrated with multiple levels of leverage and generally identified with the reference numeral 20. As shown, the investment structure includes two classes of investors: unlevered investors 22 and levered investors 24 (although this structure also could accommodate multiple classes of levered investors). The investors 22 and 24 invest in separate feeder funds 26 and 28, respectively. The feeder fund 26 is an unlevered feeder fund. For every dollar invested by the unlevered investor 22 in the unlevered feeder fund 26, one dollar is invested into a master fund 30 and the unlevered investor receives one dollar in interests of the master fund 30. On the other hand, the levered investor 28 invests in a levered feeder fund 28, and for every dollar the levered investor 24 invests in the levered feeder fund 28, the levered feeder fund 28 borrows one dollar in the form of a class loan from a lender 32. Thus, for every dollar invested by the levered investor 24, two dollars are invested into the master fund 30, providing leverage at the investor level. In this case, the levered investor receives two dollars in interests or shares of the master fund 30, which are pledged as collateral for the class loan. The collateral is held by a custodian 31. Based on the above scenario, the unlevered investor 22 and the levered investor 24 invest a total of three dollars into the master fund. The funds from the master fund 30 are used to open and maintain a prime brokerage account 34.
In this structure, a second level of leverage is provided at the portfolio level in the form of a margin loan provided by the prime broker to the master fund through the prime brokerage account 34.
There are disadvantages of such an investment structure. In particular, because the only collateral for the class loan is the levered feeder fund's 28 interest in the master fund 30 and such interests are subject to redemption, the lender, such as the lender 32, often requires relatively high interest rates and higher asset coverage (i.e., lower loan to value ratio). The lender 32 also may require a guarantee from the master fund 30 on a pro rata basis based on the ratio of the levered funds to the total funds. Although it may be prudent to require a guarantee, lenders may forego such requirement because of the legal complexity and expense. In addition, the documentation required for this structure is extensive and typically includes (a) a credit agreement between the levered feeder fund 28 and the lender 32, (b) a security agreement between the levered feeder fund 28 and the lender 32, (c) a custody agreement between the levered feeder fund 28 and the custodian, (d) a control agreement between the lender 32, the levered feeder fund 28 and the custodian, (e) a promissory note issued by the levered feeder fund 28 to the lender 32 and the custodian, (f) a guaranty and security agreement between the master fund 30 and the lender 32, (g) an acknowledgment and consent between the master fund 30, the levered feeder fund 28 and the lender 32, (h) a prime brokerage agreement between the master fund 30 and the lender 32, as prime broker and margin leverage provider, and (i) various ancillary agreements between the leveraged feeder fund 28, the lender 32 and various service providers. This extensive documentation results in significant legal expenses that must be incurred to implement the structure.
A second known approach uses a reverse master-feeder investment structure with segregated accounts, for example, as shown in FIG. 2. In this investment structure, both unlevered investors 38 and levered investors 40 invest directly into a common master fund 42. In this example, no leverage is applied at the master fund 42 level. The master fund 42 then invests in segregated reverse feeder funds 44 and 46. One feeder fund 44 is strictly for unlevered funds from the master fund 42 while the second feeder fund 46 is for levered funds from the master fund 46. Each of the feeder funds 44 and 46 opens a separate prime brokerage account 48 and 50. The prime brokerage accounts 48 and 50 are segregated with only one account obtaining additional margin lending. In particular, the prime brokerage account 48 is used for unlevered investors 36 while the prime brokerage account 50 is used for levered investor 40.
In this case, leverage is provided only at the level of the prime brokerage accounts 48 and 50 and thus no collateral is required from the levered investors 40. For each dollar in the prime brokerage account 48, a one dollar margin loan is obtained from the prime broker 52. For each dollar maintained in the prime brokerage account 50, a three dollar margin loan is obtained from the Prime Broker 52.
Although the reverse master-feeder investment structure reduces the costs to the levered investors, there are several disadvantages to such an investment structure. In particular, the portfolio manager must execute two trades for every investment strategy to segregate the levered trading from the unlevered trading. This results in a cumbersome, inefficient means of trading, and more complicated trade reconciliation processes.
In both structures described above, there are ongoing administrative and operational expenses resulting from the need to create and maintain multiple entities to achieve the desired leverage at the investor level. Thus, there is a need for an investment fund that solves the various problems discussed above by providing an investment fund structure with legal, operational and cost efficiency.